The potential effects of labour market duality for countries in a monetary union

Published date01 December 2016
Date01 December 2016
DOIhttp://doi.org/10.1111/j.1564-913X.2015.00050.x
International Labour Review, Vol. 155 (2016), No. 4
Copyright © The authors 2016
Journal compilation © International Labour Organization 2016
The potential effects of labour market
duality for countries in a monetary union
Anna KOSIOR,* Michał RUBASZEK** and Kamil WIERUS*
Abstract. This article investigates whether the varying prevalence of temporary
employment contracts across Economic and Monetary Union (EMU) countries
can explain their different unemployment dynamics. Using a database of labour
market institutions, dynamic panel regressions are carried out for 11 eurozone
countries for 1995 –2013. Labour market duality – i.e. the co-existence of perman-
ent and temporary contracts – is found to have a robust and signicant effect
on unemployment dynamics: a high duality rate increases the response of un-
employment to output shocks while decreasing its persistence. The authors suggest
that introducing a “single contract” could improve stability at both eurozone and
country level.
Before the establishment of the Economic and Monetary Union (EMU)1
there was widespread debate on whether the countries planning to
adopt the euro shared enough similarities to be able to function smoothly
using a single currency. The debate focused mainly on the importance of labour
exibility and product market exibility in facilitating adjustment to asym-
metrical shocks. Much less emphasis was placed on the fact that differences
in labour market regulation among EMU countries could lead to asymmet-
rical responses to common shocks – for example, changes in monetary policy.
* National Bank of Poland, emails: anna.kosior@nbp.pl and kamil.wierus@nbp.pl. ** Na-
tional Bank of Poland and Warsaw School of Economics, email: michal.rubaszek@nbp.pl. This paper
was presented in 2014 at the conference “European labour markets and the euro area during the
Great Recession: Adjustment, transmission, interactions” (Bratislava, Slovakia), the 18th Annual
International Conference on Macroeconomic Analysis and International Finance (Rethymno, Greece)
and an internal National Bank of Poland seminar. The authors would like to thank Stephen Bond
and Christian Merkl, the anonymous referee, and the participants at the above events for their use-
ful comments and suggestions. The views expressed in this article are those of the authors and do
not necessarily reect the views of the National Bank of Poland.
Responsibility for opinions expressed in signed articles rests solely with their authors, and
publication does not constitute an endorsement by the ILO.
1 For the sake of convenience, the terms “EMU countries” and “eurozone countries” are
used synonymously throughout the article. In reality, however, only those EU Member States that
have committed to the third stage of EMU have adopted, or will adopt, the euro as their national
currency. Denmark and the United Kingdom have legal opt-outs from the obligation to participate
in the third stage of EMU.
International Labour Review510
One example of such heterogeneity with potentially strong implications for the
functioning of a monetary union is that of labour market duality, i.e. the use of
xed-term, or temporary, contracts alongside regular, or “permanent” contracts.
The current widespread use of xed-term contracts in selected EMU coun-
tries is the result of the way labour market institutions have ddeveloped since
the early 1970s. As noted by Blanchard, Bean and Münchau (200 6), the increase
in the unemployment rate in EU-15 from 2 per cent at the start of the 1970s to
5 per cent at the end of the decade (but over 10 per cent in Spain) – which was
triggered by the shock of oil price increases – led to major changes being made
to labour market institutions, including more stringent employment protection
legislation (EPL). These changes, however, did not reduce unemployment rates,
which remained high long after the effects of the shocks had receded. It became
evident that some of these changes had probably contributed to the persistence
of unemployment; hence the pressure arose to reverse them. However, the re-
versal did not take the form of a return to earlier institutions; rather, two new
types of labour contracts were introduced: highly protected permanent contracts
and less protected temporary contracts (also see De Grip, Hoevenberg and Wil-
lems, 1997, for their analysis of atypical employment). The best known examples
are the Spanish reforms of 1984, which saw the share of temporary workers as
a percentage of total employment rise to around 30 per cent (Bentolila, Dolado
and Jimeno, 2011). Even though the use of xed-term contracts is less prevalent
in other EMU countries, over the past three decades most EMU countries have
seen a considerable increase in this type of contract.
In this article we contribute to the literature by discussing the potential
effects of labour market duality for countries in a monetary union. On the basis
of longitudinal data for EMU countries we show that the dynamic response of
unemployment to output shocks depends on labour market institutions, particu-
larly the share of temporary employment – i.e. the percentage of workers with
xed-term contracts as a share of total employment. In other words, the dispar-
ities in the labour market institutions of EMU countries lead to asymmetrical
reactions to common shocks, thereby increasing macroeconomic instability. We
believe that these results are particularly important in light of the recent debate
on the reform of EMU institutions, including proposals for partial harmonization
of labour market institutions. Moreover, the results might be helpful for coun-
tries planning to adopt the euro. For example, given that Poland has the highest
share of temporary workers among EU Member States, our results would sug-
gest that before joining the EMU, it would be useful for Poland to consider la-
bour market reforms to reduce the prevalence of xed-term contracts.
The remainder of the article is organized into ve sections. The rst pre-
sents a review of the relevant literature. The second section contains descrip-
tive statistics on the effect of labour market duality on EMU economies. The
third presents the data and methodology and the results of the panel regres-
sions carried out. The fourth section discusses the policy implications for a
country belonging to a monetary union, while the fth and last section pre-
sents the authors’ conclusions.

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